When Does a Reverse Mortgage Make Sense?
Using Home Equity to Generate Retirement Income
Aug 9, 2009
As if retirement weren’t challenging enough, today’s seniors have a few more worries on their minds. The 2008 stock market tumble has eroded their investment accounts. Low interest rates make it difficult to renew maturing CDs or bonds at attractive rates. The ongoing recession makes it more difficult to secure a part-time job for additional income. To top it all off, seniors are living longer than ever before, which means their income sources may have to last longer than they anticipated.
Seniors in Search of Retirement Income
For many retirees, their home represents one of the largest and most valuable assets in their entire portfolio. Unlike other assets, the home is widely regarded as a “use” asset that does not generate income for retirement. Regardless of the home’s value, seniors must live somewhere, which could negate selling the current home.
Those who wish to sell the home and “downsize” to a smaller home or apartment are challenged by weak home prices in a depressed housing market and tighter credit standards for potential home buyers. As a result, these retirees may have to stay put in their current homes longer than they originally planned.
Home Equity Income Source
For retirees seeking to generate additional income from their homes, taking on a second mortgage or home equity line of credit may not be practical or attractive. Someone who needs additional income really doesn’t need an additional loan payment, and tighter lending practices may make it tougher to qualify for these loans.
A reverse mortgage can be a practical alternative that provides additional income, allows the retiree to remain in the home, and does not require monthly payments to repay the loan. Available only to seniors age 62 or older, a reverse mortgage is an agreement between the homeowner and a reverse mortgage lender, whereby the lender agrees to make payments to the homeowner for life or for a fixed number of years.
Unlike a typical mortgage, a reverse mortgage lender requires no credit checks or income requirements to qualify a homeowner for a reverse mortgage. The amount one can borrow via a reverse mortgage is based on both the value of the home and the age of the homeowner. Older homeowners can qualify to borrow larger amounts than younger homeowners. Also, the existing mortgage should be fully paid or only have a small remaining balance for the reverse mortgage to work properly.
Potential Reverse Mortgage Pitfalls
A reverse mortgage loan becomes payable if the home is sold, transferred, or upon the death of the survivor of a home owning couple. Proceeds from the eventual sale of the home are used to repay the reverse mortgage loan. Thus, for those who intend to pass along the home to their heirs or to a charity, a reverse mortgage may not be an appropriate choice.
Fees for reverse mortgage loans are also considerably higher than those for other mortgages. According to an article by Mary Beth Franklin in the August 2009 edition of Kiplinger’s Personal Finance, “Reverse Mortgages to the Rescue,” a reverse mortgage loan includes origination fees of up to $6,000 along with the typical loan servicing fees and closing costs.
Perhaps what makes these loans particularly pricey is the Federal Housing Administration (FHA) insurance requirement. This insurance protects the lender and the homeowner against a decline in the home’s value, ensuring the borrower would never be required to repay more than the home’s actual value. The initial FHA insurance premium equals 2% of the home’s value, plus 0.5% of the monthly mortgage balance.
More reverse mortgage information is available from the National Center for Home Equity Conversion (NCHEC). Their website also has a reverse mortgage calculator to help individuals determine how much income they might derive from a reverse mortgage. As with all major financial decisions, anyone considering a reverse mortgage is advised to consult with a financial planner and a tax professional before taking action.
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